Lesson 1.1: Equity Securities

A security is an investment representing either an ownership stake (equity) or a debt stake. Buying stock makes you a part owner of a corporation. Buying a bond makes you a creditor — you're owed interest and repayment of principal at maturity, but you don't gain any ownership.

Stockholders benefit from a company's success two ways: dividends (a share of earnings paid out) and price appreciation (the stock becoming more valuable). Ownership is proportional to shares held — if a company has 1,000 shares outstanding, owning 10 of them means owning 1% of the company.

There are two types of stock:

• Common stock — the "default" type. Gives a proportional claim on earnings and, typically, one vote per share to elect the board of directors, who oversee (but don't run day-to-day) the company.
• Preferred stock — also ownership, but usually no voting rights and less room for the price to appreciate. Pays a fixed dividend (usually quarterly) that must be paid before common shareholders get anything, and preferred holders have first claim on remaining assets if the company is liquidated.

Keep the payment order straight: bond interest is always paid before any dividend (it's a contractual debt obligation, not a discretionary payout), then preferred dividends, then common dividends last.

Even though preferred stock is equity, it behaves a bit like a bond: because its dividend is fixed, its price tends to move with interest rates rather than with the company's business prospects — this is sometimes called interest rate (or "money rate") risk.

Common stock's other big draw is capital appreciation — growth in the stock's market price over time. Historically, common stock returns have outpaced inflation over the long run, which is why long-term investors often hold it as an inflation hedge — though prices can still decline, especially in the short run.

Dividends & Stockholder Rights

Dividends aren't guaranteed. Unlike bond interest, a company's board of directors decides whether to pay a dividend and how much — including paying nothing at all. Most dividends are cash, but a company can instead pay a stock dividend (extra shares) or a property dividend (assets like shares of a subsidiary or company products). Common or preferred, stock can be freely transferred to anyone without the company's permission, and common stockholders vote for the board of directors at the annual meeting.

Stock Dividends vs. Stock Splits

A stock dividend gives shareholders extra shares instead of cash. Since the company takes in no new money, the price adjusts down proportionally so total value is unchanged — e.g., an investor with 200 shares at $30 ($6,000 total) who receives a 10% stock dividend ends up with 220 shares at roughly $27.27 each — still about $6,000. Stock dividends aren't taxed when received; they simply lower your cost basis per share until you sell.

A stock split is different — it's an accounting change to the number of shares outstanding, with no dividend involved. In a 2-for-1 split, you'd end up with twice as many shares worth half as much each — like trading a $20 bill for two $10 bills. Either way, no real value is created or lost.

More Stockholder Rights

Shareholders are entitled to an annual report of audited financial statements. Selling shares routes through the issuer's transfer agent (usually a bank, registered with the SEC), which reissues the certificate to the new owner — conceptually the same as transferring the title on a car. To vote or receive a declared dividend, you must be the owner of record by the company's record date.

Liquidity & Limited Liability

Common and preferred stock are both generally freely transferable — no permission needed from the issuer to sell in the open market. (One exception: restricted stock, which is subject to SEC Rule 144.) Stock ownership also comes with limited liability: if the company goes bankrupt, you can lose what you invested, but your personal assets are never at risk. That's different from a sole proprietorship or general partnership, where the owner's personal assets can be on the hook for business debts.

Benefits & Risks of Owning Common Stock

Why hold common stock in a portfolio? Potential capital appreciation, dividend income, and an inflation hedge. The trade-off is real risk:

• Market risk — the stock's price can decline as perceptions of the business change, with no guarantee you'll recover your investment.
• Business risk — a decline in the company's earnings can reduce or eliminate its dividend.
• Low priority at dissolution — bonds and preferred stock are "senior securities" paid first in bankruptcy; common stockholders only have a residual claim on whatever is left.

One common misconception: simply becoming a shareholder doesn't give you access to insider information — and even if you somehow obtained material nonpublic information, trading on it is illegal (see insider trading in Domain IV).

Benefits & Risks of Owning Preferred Stock

Why hold preferred stock instead? Fixed dividend income, a priority claim ahead of common stock, and — for convertible preferred — the option to trade some of that income for potential appreciation. The risks:

• Market risk — in a downturn, fear that the company can't sustain its dividend will push the price down.
• Purchasing power (inflation) risk — a fixed dividend loses value over time as prices rise.
• Interest rate risk — since the dividend is fixed, the price moves opposite to interest rates, just like a bond.
• Business risk — financial trouble can reduce or eliminate the dividend, and bankruptcy can mean losing the principal entirely.

Lesson 1.2: Special Types of Equity Securities

All preferred stock starts from a base case — straight preferred — and gains extra features as adjectives get added, but every type still ranks ahead of common stock. Dividends are stated either as a flat dollar amount ($6 preferred) or as a percentage of par value ($100 par at 6% = $6/year), and — with one exception below — they're fixed, which is why many advisors treat preferred stock as a fixed-income holding for asset allocation purposes.

• Straight (noncumulative) — no extra features. If a dividend is missed, it's gone for good; the company owes nothing extra later.
• Cumulative preferred — missed dividends accumulate as "dividends in arrears." Before common stockholders can be paid anything, the company must pay all arrears plus the current dividend to cumulative preferred holders.
• Callable (redeemable) preferred — the company can buy the shares back at a stated price after a set date, letting it replace a high fixed dividend with a cheaper one when rates fall (like refinancing a mortgage). The investor then faces reinvestment risk — having to reinvest the proceeds at a lower rate. Companies compensate for this with a call premium (e.g., a $103 call price on $100 par) and a somewhat higher dividend rate.
• Convertible preferred — exchangeable for a fixed number of common shares, so its price tends to track the common stock. Usually carries a lower stated dividend than non-convertible preferred of similar quality, since the conversion feature adds upside potential.
• Adjustable-rate (floating-rate) preferred — the dividend resets periodically against a benchmark (like T-bill rates), so the stock's price stays comparatively stable since the payment moves with the market.

A single preferred stock can combine features — cumulative and callable, callable and convertible, and so on. If no adjectives are mentioned, assume it's straight preferred. And because income is the main reason to buy preferred stock, the most important thing to evaluate for any specific issue is the company's ability to keep paying its dividend.

Employee Stock Options

Some equity questions on the exam deal with stock employees buy directly from their employer through a stock option grant, rather than stock purchased on the open market. An option gives the employee the right to buy a set number of employer shares at a stated strike price (usually the market price on the grant date) during a set window, often after a minimum vesting period. There are two types, each with very different tax treatment: nonqualified stock options (NSOs) and incentive stock options (ISOs). (Don't confuse these with publicly traded puts and calls — these options are only available to employees of the issuing company.)

• NSOs — the more common type. Treated as compensation: at exercise, the "bargain element" (market price minus strike price) is taxed as ordinary income (and subject to payroll tax) to the employee, while the employer gets a matching salary-expense deduction. Example: exercising at a $52 strike when the market price is $66.50 creates a $14.50/share bargain element — on 100 shares, that's $1,450 of ordinary income; going forward, the employee's cost basis is the strike price plus that already-taxed amount.
• ISOs — no tax consequence to the employer. No income at grant, no regular tax due at exercise. If the shares are held at least 2 years from the grant date and 1 year from the exercise date (with a 10-year maximum to exercise), the eventual profit is taxed as a long-term capital gain — otherwise it's taxed like an NSO. The catch: the bargain element at exercise is still an add-back item for the alternative minimum tax (AMT), even though no regular tax is due yet.

Restricted Stock & Control Stock

Stock is normally freely transferable, but there are two testable exceptions:

• Restricted stock — shares acquired through a private placement (an offering exempt from full SEC registration). Investors generally can't resell them until a holding period has passed (commonly six months), and affiliates of the issuer also face volume limits on how much can be resold.
• Control stock — stock owned by a control person: a director, officer, large stockholder, or immediate family sharing their home. It's control stock because of who owns it, not how it was acquired. Purchases and sales must be reported to the SEC, and volume limits always apply.

Lesson 1.3: Foreign Equity Securities

Foreign stocks can be hard for U.S. investors to trade directly — different currency, language, and settlement systems. American Depositary Receipts (ADRs), also called American Depositary Shares (ADSs), solve this.

An ADR is a negotiable security representing a receipt for shares of a non-U.S. company, traded on U.S. exchanges just like a domestic stock — priced in U.S. dollars, with dividends paid in U.S. dollars, and all paperwork in English.

One ADR doesn't always equal one underlying share. Depending on the company, an ADR might represent one share, several shares, or a fraction of a share. This ratio (the participation rate) is set so the ADR trades at a price that looks typical for the U.S. market, even if the underlying foreign share trades at a very different price. (Example: at a 1:5 ratio, one ADR equals five underlying shares — the exact math isn't tested, just the concept that ratios other than 1:1 exist.)

Rights & Risks of ADRs

ADR owners get most of the same rights as regular common stockholders, including dividends, and sometimes — but not always — voting rights. For exam purposes, ADRs never carry preemptive rights.

Beyond the usual risks of owning stock, ADR investors also take on currency risk — the foreign currency the underlying shares are denominated in could weaken against the U.S. dollar, reducing the ADR's value even if the foreign stock itself performs fine.

On the flip side, because most ADRs trade on U.S. exchanges, liquidity risk is generally low, and since an ADR represents equity, it can still serve as a reasonable inflation hedge like other stocks. Currency risk and market risk are the two main concerns for an ADR holder — not liquidity or purchasing power.

Emerging vs. Developed Markets

Foreign markets fall into two broad categories:

• Emerging markets — less-developed countries with low income (GDP) and equity capitalization, shaky liquidity, possible currency-conversion restrictions, high volatility, higher taxes/commissions, ownership restrictions, and weaker regulation and transparency. The upside: strong growth potential often attracts investors from slower-growing developed markets. (An even riskier tier, "frontier markets," sits below emerging markets, though it's not yet a major exam topic.)
• Developed markets — stable, established economies with large equity capitalization, low commissions, few currency restrictions, highly liquid markets, and well-defined regulation with transparency comparable to U.S. markets.

Why add foreign securities to a portfolio at all? They expand the investable universe (more diversification), can outperform domestic securities, and tend to have lower correlation with domestic securities, which reduces overall portfolio risk.

That said, foreign investing — emerging or developed — carries risks domestic investing doesn't:

• Country risk — a composite of political risk (revolutions, coups), structural risk (a government seizing profits, capital gains, or dividends), and economic risk (interest rates, inflation, policy shifts).
• Exchange controls — government restrictions on converting or moving currency across borders.
• Currency risk — the foreign currency weakening against the U.S. dollar.
• Withholding, fees, and taxes — some countries withhold part of dividends or capital gains for tax, and foreign investing can carry heavier fees, taxes, and brokerage commissions than domestic investing.

Lesson 2.1: Bond Basics & U.S. Government Securities

A bond is a loan: the issuer borrows money from investors and promises to pay it back. The bondholder is a creditor, not an owner — no voting rights, no dividend, just a contractual right to interest and principal. Every bond has a par (face) value (almost always $1,000), a coupon rate (the fixed annual interest rate, stated as a % of par), and a maturity date (when the issuer repays the par value in full).

Most bonds pay interest semiannually — half the annual coupon every six months. A $1,000 par bond with a 6% coupon pays $60/year, or $30 every six months. (There's an important exception to this semiannual rule — covered in Lesson 2.3.)

U.S. Treasury Securities

• Treasury Bills (T-Bills) — maturities of 1 year or less. Sold at a discount to par with no stated coupon; the investor's return is simply the difference between the discounted purchase price and the $1,000 received at maturity.
• Treasury Notes (T-Notes) — maturities of 1–10 years, pay a fixed coupon semiannually.
• Treasury Bonds (T-Bonds) — maturities of 20–30 years, also pay a fixed coupon semiannually.
• TIPS (Treasury Inflation-Protected Securities) — the principal adjusts up or down with the Consumer Price Index (CPI), and the fixed coupon rate is then applied to that adjusted principal, so the actual interest payment rises with inflation. At maturity, an investor is repaid the greater of the inflation-adjusted principal or the original par value — deflation can't reduce their principal below the starting $1,000.
🎮 Try it — TIPS Adjustment
💡 What to try: Slide into negative territory (deflation) and watch the adjusted principal fall — then notice the readout still guarantees at least the original $1,000 back at maturity.
$1,000 par, 3% fixed coupon rate.
Cumulative CPI change since issuance +3%

All Treasury securities are taxable at the federal level but exempt from state and local tax — the reverse of how municipal bonds are typically treated (Lesson 2.2).

Lesson 2.2: Corporate & Municipal Bonds

Corporate Bonds

Corporate bonds are fully taxable — federal, state, and local. They can be secured (backed by specific collateral, like a mortgage bond backed by real property or an equipment trust certificate backed by equipment) or unsecured (a debenture, backed only by the issuer's general creditworthiness). Independent rating agencies (Moody's, S&P, Fitch) grade corporate (and municipal) bonds by default risk — investment grade (BBB-/Baa3 and above) versus high-yield/"junk" (below that threshold), which must offer a higher yield to compensate for the added risk.

Municipal Bonds

• General obligation (GO) bonds — backed by the issuer's full faith, credit, and taxing power. Because they pledge tax revenue, GO bonds typically require voter approval.
• Revenue bonds — backed only by the income generated by the specific project being financed (a toll road, a stadium, a water utility). Since no tax dollars are pledged, revenue bonds generally do not require voter approval — instead, a feasibility study is used to project whether the project will generate enough revenue to cover the debt.

Municipal bond interest is exempt from federal tax, and typically also exempt from state and local tax if the investor lives in the issuing state (sometimes called "double exempt," or "triple exempt" when local tax is also avoided). An insured municipal bond carries a guarantee from a bond insurer that principal and interest will be paid even if the issuer defaults — investors accept a somewhat lower yield in exchange for that added safety.

Foreign-issued bonds (sovereign/government debt or foreign corporate debt) work on the same basic principles, with the added factor of currency risk if payments are made in a foreign currency.

Lesson 2.3: Bond Pricing, Yield & Special Structures

Bond price and yield move in opposite directions — this is the single most useful relationship in the whole unit. Picture a seesaw with a fixed pivot at the coupon rate (which never changes for the life of the bond): when price drops below par (a discount bond), the yield side rises, and the order from lowest to highest is always coupon → current yield → YTM (yield to maturity) → YTC (yield to call). When price rises above par (a premium bond), that order flips completely.

Duration measures how sensitive a bond's price is to interest-rate changes — the longer the duration (generally tied to longer maturities and lower coupons), the more the price swings for a given rate change.

Zero-Coupon Bonds

A zero-coupon bond pays no periodic interest at all — it's purchased at a deep discount and grows to full face value at maturity. Even though no cash changes hands along the way, the IRS requires the holder to report a portion of that built-in growth as taxable "phantom income" every single year. Treasury zero-coupons (STRIPS) carry zero credit risk since the U.S. government backs them; municipal and corporate zero-coupons still carry real credit/default risk.

Callable & Convertible Bonds

A callable bond gives the issuer the right to redeem it early (usually when rates have fallen, so they can refinance more cheaply) — because this exposes the investor to reinvestment risk, callable bonds typically carry a higher coupon. A convertible bond gives the investor the right to exchange it for a set number of common shares — because this adds upside potential for the investor, convertible bonds typically carry a lower coupon. Same logic as callable vs. convertible preferred stock in Unit 1, just applied to debt.

CMOs, Mortgage Pass-Throughs & Asset-Backed Securities

CMOs (Collateralized Mortgage Obligations) and mortgage pass-through securities (like Ginnie Mae/GNMA) are backed by pools of mortgages — and unlike regular bonds, they pay monthly, not semiannually, with each payment including both interest and a partial return of principal. Asset-backed securities apply the same pooling-and-securitizing concept to other debt, like auto loans or credit card receivables, rather than mortgages.

Lesson 3.1: Open-End vs. Closed-End Funds

An open-end fund (the traditional "mutual fund") continuously issues new shares as investors buy in and redeems shares as investors sell — there's no fixed share count. It can only issue common stock, is priced once per day after the market closes, and always transacts at that day's Net Asset Value (NAV) — (fund assets − liabilities) ÷ shares outstanding.

A closed-end fund raises money once through an IPO, issuing a fixed number of shares, then trades on an exchange all day just like a stock. Because its price is set by supply and demand rather than a formula, a closed-end fund can trade at a premium or discount to its NAV. Unlike an open-end fund, a closed-end fund can also issue bonds and preferred stock to add leverage.

Lesson 3.2: ETFs, UITs & Private Funds

An ETF (exchange-traded fund) trades throughout the day on an exchange, just like a closed-end fund — but unlike a closed-end fund, an ETF's structure (in-kind creation and redemption by large institutional players) keeps its market price closely tethered to its NAV. ETFs can be bought on margin and sold short, and generally carry lower expense ratios than actively managed mutual funds. A regular open-end mutual fund can do none of those things — no margin, no short selling, priced only once a day.

A UIT (Unit Investment Trust) holds a fixed, unmanaged portfolio (no buying or selling of holdings after formation) and has a set termination date, unlike an actively managed fund with an ongoing portfolio manager.

Private funds — hedge funds, private equity, and venture capital — are sold only to accredited/qualified investors, face far less regulatory oversight than mutual funds, and can freely use leverage, short-selling, and derivatives. In exchange for that flexibility, they're typically illiquid, often locking up investor money for extended periods.

Lesson 3.3: REITs, DPPs & Comparing Pooled Investments

A REIT (Real Estate Investment Trust) must satisfy a 3-part test to keep its favorable tax status: at least 75% of assets in real estate (plus cash), at least 75% of gross income from real estate sources, and it must distribute at least 90% of its taxable income to shareholders. REITs can be liquid (publicly traded, like a stock) or non-liquid/non-traded (much harder to sell). Despite the high distribution requirement, a REIT does not pass through losses to investors — only income.

A direct participation program (DPP), such as a real estate limited partnership (RELP), is the opposite on that one point: a DPP passes through both income and losses to its investors, which is exactly why an investor specifically seeking passive losses to offset other income would choose a DPP over a REIT. DPPs are generally illiquid, with a general partner (GP) bearing unlimited liability and limited partners (LPs) risking only their investment.

When comparing any two pooled investments, the standard factors are: benchmarks (has the fund tracked or beaten its relevant index?), manager tenure (how long has the current manager been running it?), style (growth vs. value vs. income), and fee structure (expense ratio, loads, 12b-1 fees).

Lesson 4.1: Options Basics

A call option gives its buyer the right (not obligation) to buy a stock at a set strike price; a put option gives the right to sell at that strike price. Think "call up" (in the money when the stock price is above the strike) and "put down" (in the money when the stock price is below the strike).

Buying an option caps the maximum loss at the premium paid, no matter how far the trade moves against the buyer. Selling an uncovered (naked) option is the opposite: since the stock's price has no ceiling, a naked call seller's potential loss is unlimited.

Lesson 4.2: Warrants & Futures

A warrant looks like a long-term option but is issued directly by the company itself, often attached to a bond or preferred stock offering as a "sweetener." Exercising a warrant creates brand-new shares — which dilutes existing shareholders. Exercising a regular exchange-traded option, by contrast, simply transfers existing shares between two investors and creates no dilution at all.

A futures contract obligates both parties — one to buy, one to sell — a specific asset at a set price on a future date. Unlike an option (a one-sided right that the buyer can simply let expire), a futures contract is a firm obligation for both sides, and positions are marked-to-market daily.

Lesson 4.3: Why Investors Use Derivatives

Three common uses: hedging (buying a put to protect a stock position already owned), speculation (a leveraged directional bet with a relatively small premium outlay), and income generation (writing a covered call against stock already owned — collecting the premium as income, with the "cost" being a cap on further upside if the stock is called away).

Lesson 5.1: Limited Partnerships & Structured Products

A direct participation program (DPP) — commonly structured as a limited partnership investing in real estate, oil and gas, or equipment leasing — passes through both income and losses to its investors, unlike a REIT (Unit 3), which passes through income only. The general partner bears unlimited liability; limited partners risk only their investment.

A structured product combines a bond with a derivative, offering returns tied to an underlying index or asset, sometimes with a degree of principal protection. These products are typically complex, often illiquid, and carry a real risk that investors don't fully understand what they've actually bought.

Lesson 5.2: Exchange-Traded Notes, Leveraged & Inverse Funds

An ETN (Exchange-Traded Note) looks similar to an ETF but is structurally very different: it's an unsecured debt obligation of the issuing bank that promises to track an index's return — meaning an ETN holder carries the issuer's credit risk. If the issuing bank defaults, ETN holders could lose money regardless of how the underlying index performed. A regular ETF, by contrast, actually holds the underlying assets, so it doesn't carry this same issuer credit risk.

Leveraged funds use derivatives and borrowing to amplify daily returns (2x or 3x an index); inverse funds are built to move opposite an index. Both rebalance daily, so due to compounding effects, their returns over weeks or months can diverge significantly from a simple multiple of the index's return — these are short-term trading tools, not long-term buy-and-hold investments.

Lesson 5.3: Commodities, Precious Metals & Digital Assets

Commodities and precious metals (gold, oil, agricultural products) can be accessed through futures contracts, ETFs, or direct physical ownership, and are often used as an inflation hedge or portfolio diversifier due to historically low correlation with stocks and bonds. Digital assets (cryptocurrencies and related instruments) are a newer, highly volatile category — whether a specific digital asset counts as a security, a currency, or something else is determined case by case based on its actual characteristics, not automatically one way or the other.

Lesson 6.1: Business Cycles & Monetary/Fiscal Policy

The economy moves through a repeating business cycle: expansion (growth, rising employment) → peak → contraction (a sustained decline, a recession if severe/prolonged enough) → trough → back to expansion. Different asset classes and sectors tend to perform differently at each phase, which is the foundation for sector-rotation strategies covered later in the course.

Two distinct levers influence the economy, and mixing them up is a common exam trap:

• Monetary policy — set by the Federal Reserve (the Fed), an independent central bank, using tools like the fed funds rate (the rate banks charge each other overnight), open market operations (buying Treasury securities to add money to the system and lower rates, or selling them to remove money and raise rates), and reserve requirements.
• Fiscal policy — set by Congress and the President through taxation and government spending decisions, not the Fed.

Expansionary policy (lower rates, more spending, tax cuts) aims to stimulate a slowing economy; contractionary policy (higher rates, less spending, tax increases) aims to cool down an overheating one, usually to fight inflation.

Lesson 6.2: Interest Rates, Yield Curves & Inflation

A yield curve plots interest rates across different maturities at a point in time. A normal yield curve slopes upward — longer maturities pay more, since investors demand extra compensation for tying up money longer. An inverted yield curve is the opposite: short-term rates exceed long-term rates, and it's widely watched as one of the more reliable warning signs of a coming recession, since it suggests investors expect rates (and growth) to fall.

A credit spread is the yield gap between a corporate bond and a Treasury of the same maturity. Spreads widen when investors grow nervous about credit risk (demanding more extra yield to hold corporate debt) and narrow when confidence is high.

Inflation (rising prices, measured primarily by the Consumer Price Index, CPI) erodes purchasing power over time — this is the same concept behind the "real rate of return" calculation (nominal return minus inflation). Deflation (falling prices) sounds appealing but usually signals serious economic weakness, since it often comes with falling wages and demand.

Lesson 6.3: Global Factors & Economic Indicators

A strong (appreciating) dollar makes imports cheaper for U.S. consumers but makes U.S. exports more expensive for foreign buyers, hurting exporters. A weak (depreciating) dollar does the reverse — it helps exporters but makes imports more expensive. Sovereign debt levels and geopolitical instability abroad can also ripple into U.S. markets through trade and currency effects.

Key economic indicators to recognize:

• GDP (Gross Domestic Product) — the total value of goods and services produced; the headline measure of economic growth. Two consecutive quarters of GDP decline is a commonly cited (though informal) definition of a recession.
• Employment indicators — the unemployment rate and jobless claims signal labor-market health.
• Trade deficit — occurs when a country imports more than it exports.
• CPI — the standard measure of inflation, already introduced in Lesson 6.2.

Lesson 7.1: The Three Core Financial Statements

• Income statement — revenue minus expenses equals net income, covering a specific period of time (a quarter or a year).
• Balance sheet — assets = liabilities + equity, a snapshot at one single point in time (not a period).
• Statement of cash flows — tracks actual cash moving in and out across operating, investing, and financing activities, over a period of time.

Lesson 7.2: Accounting Fundamentals & Auditor Opinions

Cash-basis accounting records a transaction only when cash actually changes hands. Accrual-basis accounting (used by virtually all public companies) records revenue when it's earned and expenses when they're incurred, regardless of when the cash actually moves — which is exactly why a company's reported net income and its actual cash position can diverge, and why the cash flow statement exists as a separate check.

Audited financial statements have been independently examined by an outside accounting firm; unaudited statements haven't, and carry far less assurance. An auditor's opinion on audited statements comes in two common flavors: an unqualified opinion ("clean" — no material issues found) and a qualified opinion (the auditor is flagging some specific exception or limitation).

Lesson 7.3: SEC Filings & Annual Reports

Public companies file several standard reports with the SEC: the 10-K (comprehensive annual report, audited), the 10-Q (quarterly update, unaudited), and the 8-K (filed promptly whenever a major event occurs — a merger, executive departure, bankruptcy, etc.). The annual report to shareholders also contains audited financials, but is typically more narrative and shareholder-facing than the denser, more standardized 10-K.

Lesson 8.1: What Counts as a Security & Registration Methods

The legal definition of a security is intentionally broad — far beyond just stocks and bonds, it includes investment contracts (any arrangement where someone invests money in a common enterprise expecting profit primarily from the efforts of others), among many other instruments.

Securities can register at the state level three ways:

• Notification — a streamlined method available only to well-established issuers that already meet specific track-record requirements.
• Coordination — used when an issuer is simultaneously registering the same offering with the SEC at the federal level; the state registration becomes effective in coordination with the federal one.
• Qualification — the state's own full, independent review, generally used by smaller or first-time issuers who aren't eligible for the other two methods.

Lesson 8.2: Exclusions & Exemptions

Two very different concepts, constantly tested against each other: excluded means something never meets the definition in the first place; exempt means it meets the definition but is specifically excused from the registration requirement only.

Commonly exempt securities include U.S. government and municipal securities, bank and savings-and-loan stock, non-variable insurance/annuity contracts, and qualifying commercial paper (270-day maximum maturity, top-3 credit rating, $50,000+ minimum denomination). Commonly exempt transactions include private placements to accredited investors, intrastate offerings under Rule 147 (resales restricted to in-state residents for 6 months), isolated non-issuer transactions, unsolicited orders, and transactions by a fiduciary (executor, trustee, guardian) acting within their official duties.

Lesson 8.3: Issuers, Registration Statements & Enforcement

The issuer is the entity offering the security for sale, and its own selling agents must separately register. A finder merely makes an introduction between an issuer and potential investors without handling the transaction itself — but finders who are compensated based on whether a transaction closes generally still trigger registration requirements as though they were a regular agent.

A registration statement must be signed by the CEO, the CFO, and a majority of the board — three separate signature requirements — and must include a balance sheet, three years of earnings statements, the purpose of the offering, an anticipated price range, and the names/addresses/bios of officers, directors, and 10%+ owners.

The state Administrator's antifraud and enforcement authority reaches any person or transaction suspected of fraud — registered or not, exempt or not — reinforcing that registration status and antifraud liability are entirely separate tracks.

Lesson 9.1: Who Must Register as an Investment Adviser

An investment adviser is anyone giving investment advice for compensation as a regular part of their business. Depending on assets under management (AUM), an adviser registers either with the state or with the SEC (a "federally covered" adviser):

• Below $90M AUM — must register with the state.
• $100M–$110M — the "choice zone": the adviser may register with the SEC instead of the state, but isn't required to yet.
• $110M and above — SEC registration becomes mandatory.

The de minimis exemption excuses an adviser from state registration if they have 5 or fewer clients in that state and no place of business there — but this exemption applies only to investment advisers and IARs, never to broker-dealers or their agents, who must register regardless of client count.

An Exempt Reporting Adviser (ERA) advises only private funds (like venture capital funds) below certain size thresholds — exempt from full registration, but still required to file basic reports with regulators.

Lesson 9.2: Net Worth Requirements & Registration Maintenance

State-registered advisers face minimum net worth requirements: $10,000 if they have discretion but not custody, and $35,000 if they have custody of client funds/securities. If net worth falls below the required minimum, the exact sequence is: (1) notify the Administrator by close of business the next business day, (2) file a detailed financial report the day after that, and (3) obtain a bond equal to the deficiency, rounded up to the nearest $5,000.

Adviser and IAR registrations expire every December 31, regardless of when during the year they originally registered — someone registering in November still owes the full year's fee and re-registers just weeks later.

Lesson 9.3: Notice Filing & Supervision

A federally covered adviser doing business in a state doesn't register there — instead, it simply completes a notice filing (paying fees and providing paperwork copies) so the state knows the adviser is operating within its borders. Notice filing is not registration, and the state Administrator's power over a notice-filed adviser is limited mainly to collecting fees, absent actual fraud.

An advisory firm has an ongoing obligation to supervise its investment adviser representatives — reviewing their communications, monitoring for compliance issues, and maintaining adequate written supervisory procedures.

Lesson 10.1: Who Is an IAR & What Triggers Registration

An Investment Adviser Representative (IAR) is an individual associated with an investment adviser who makes recommendations, manages client accounts, solicits advisory business, or supervises those who do any of the above. What matters is the actual function performed, not the person's job title — someone with a fancy title but purely clerical duties (data entry, scheduling) is generally not an IAR, while someone titled "assistant" who actively gives investment advice is.

Lesson 10.2: Registration Maintenance

Once registered, an IAR has ongoing obligations: promptly updating Form U4 for material changes (like a change of address or a new disciplinary event), satisfying applicable continuing education requirements, and disclosing reportable events (disciplinary actions, bankruptcies, and similar disclosures) as they occur — not just at the initial registration.

Lesson 11.1: Broker-Dealer & Agent Definitions

A broker-dealer is a firm in the business of effecting securities transactions for others (acting as a broker) or for its own account (acting as a dealer) — the same broker/dealer capacity distinction from Unit 23. An agent is the individual who represents a broker-dealer in those transactions (also called a "registered representative").

Unlike investment advisers and IARs, broker-dealers and agents have no de minimis exemption. A broker-dealer or agent with even a single retail client in a state, or any office there at all, must register — there's no minimum-client pass available to them the way there is for advisers.

Lesson 11.2: Exclusions from the Definitions

Banks and savings institutions are typically excluded from the broker-dealer definition entirely. Certain individuals who transact only for the issuer's own account, without transaction-based compensation, may also fall outside the "agent" definition. As with Unit 8's securities exclusions, an exclusion here means the person or firm never meets the definition in the first place — a separate question entirely from whether an exemption from registration might apply to someone who does meet the definition.

Lesson 12.1: The Administrator's Powers

A state securities Administrator can: deny, suspend, revoke, or bar a registration (within their own state only); subpoena documents and testimony; investigate anyone suspected of a violation — registered or not, even before any investor has actually lost money; issue cease-and-desist and stop orders; and publish information about violations.

The Administrator cannot personally issue an injunction — that requires going to an actual court, where the Administrator can only ask a judge for one. The Administrator also cannot amend federal statutes, and generally cannot deny a federal covered security's notice filing absent fraud.

Regulators never say "approved." The standard language is that a filing simply hasn't been found deficient — never that it's been blessed as a good investment. A firm marketing itself as "SEC-approved" is always making a false, misleading claim, regardless of its actual registration status.

Lesson 12.2: Civil, Criminal & Administrative Remedies

Three independent enforcement tracks exist for the same underlying misconduct:

• Civil — triggered by unethical/unintentional conduct; statute of limitations is the earlier of 3 years from the sale or 2 years from discovery; the remedy is rescission (money back plus interest).
• Criminal — triggered by willful, intentional, or fraudulent conduct; a 5-year statute of limitations; penalties up to a set number of years and a dollar fine (state or federal).
• Administrative — triggered by any violation of the Uniform Securities Act; no fixed statute of limitations; penalty is deny/suspend/revoke/bar.

These three tracks are not mutually exclusive — a single bad act (say, an unregistered agent selling fraudulent securities) can trigger administrative action, a criminal prosecution, and a civil lawsuit from the harmed investor, all independently and simultaneously.

Notably, imprisonment specifically requires actual knowledge of the specific rule or order violated — a person can't be jailed for violating a rule they had no way of knowing existed. A good-faith, reasonable misunderstanding of the law generally doesn't meet the willfulness bar required for criminal liability.

Lesson 13.1: Required Disclosures & Client Contracts

Advisers must deliver their Form ADV Part 2 (the "brochure") to clients, disclosing fees, conflicts of interest, and disciplinary history. Advisory contracts must generally be in writing, and two provisions are specifically prohibited: the contract cannot be assigned to another party without the client's consent, and it cannot contain a hedge clause waiving the adviser's liability for their own negligence or misconduct — clients can't be asked to sign away that protection.

Lesson 13.2: Unlawful Representations & Guarantees

Claiming government approval or endorsement is always false and always a violation — regulators never "approve" a security or an adviser's merit, they simply don't find a filing deficient. A firm advertising itself as "SEC-approved" is misrepresenting its status regardless of its actual registration standing.

The never-guarantee-performance rule (covered fully in Unit 14) applies directly to communications too — and so does "cherry-picking": showing only an adviser's winning trades in an advertisement while omitting the losers. Even if every individual number displayed is accurate, the overall misleading impression is itself the violation.

Lesson 13.3: Advertising & Digital Communications

"Advertising" is defined broadly — it covers traditional print and media, but just as fully covers social media posts, email, and website content. The same disclosure and anti-fraud standards apply regardless of the medium; a misleading claim doesn't become acceptable just because it was posted on social media instead of printed in a brochure. Firms must also maintain proper recordkeeping for electronic communications, just as they would for paper correspondence.

Lesson 14.1: Fiduciary Duty — Care & Loyalty

An investment adviser is a fiduciary — held to the highest legal standard of care, obligated to act in the client's best interest above their own. That obligation splits into two distinct duties, and telling them apart is a frequently tested skill:

• Duty of Care (competence) — recommending unsuitable investments, ignoring stated risk tolerance, recommending without adequate research, failing to update clients on material changes, or not gathering enough client financial information.
• Duty of Loyalty (conflicts) — failing to disclose conflicts of interest, recommending products that benefit the adviser more than the client, front-running client trades, charging undisclosed excess fees, or churning an account.

Lesson 14.2: Compensation, Custody & Discretion

Advisers can be compensated through fees (flat, hourly, or AUM-based), commissions, or (for qualified/high-net-worth clients only) performance-based fees — but however they're paid, all compensation arrangements must be disclosed to the client. Soft dollars — research or services received from a broker-dealer in exchange for directing client brokerage business there — are permitted only if they genuinely benefit the client and are properly disclosed, never as an undisclosed personal perk to the adviser.

An adviser who has custody — direct access to or control over client funds/securities — faces materially stricter oversight than one who doesn't, including surprise audits and asset-segregation requirements, precisely because the opportunity for misuse is so much greater.

Discretionary authority requires the client's prior written authorization and lets the adviser decide what, whether, and how much to trade without asking each time — distinct from the narrower "time and price only" discretion covered in Unit 23.

Lesson 14.3: The Never-Guarantee Rule & Prohibited Practices

The single most-repeated absolute in the entire course: an adviser can never promise a client they won't lose money, or promise a specific return, on anything tied to the market. The violation happens the instant the statement is made — it doesn't matter if the adviser believed it, if it later turned out true, or if the client was never actually harmed. The one narrow exception: accurately describing something actually, contractually guaranteed (FDIC insurance, a fixed annuity's guaranteed minimum rate) is simply telling the truth, not a market-performance guarantee.

Other bright-line prohibited practices: commingling client funds with the adviser's own money (a violation the instant it happens, even if reversed later); borrowing from a client (unless that client is a genuine lending institution); a breakpoint sale violation (failing to tell a client they're close to a quantity discount, or deliberately structuring a sale to dodge that disclosure); insider trading; market manipulation; selling away (selling products outside the firm without authorization); and churning (excessive trading to generate commissions rather than serve the client).

Lesson 14.4: AML, Cybersecurity & Business Continuity

Advisers must maintain baseline protections beyond client-specific conduct rules: anti-money laundering (AML) awareness (recognizing and reporting suspicious transaction patterns), cybersecurity and data privacy safeguards for client information, and a written business continuity plan covering both disaster recovery (keeping the business operating through a disruption) and succession planning (what happens to client accounts if the adviser can no longer serve them).

Lesson 15.1: Individual Income Tax Basics

A capital gain is short-term if the asset was held one year or less (taxed as ordinary income) and long-term if held more than one year (taxed at generally lower, preferential rates). Qualified dividends get that same preferential long-term rate; nonqualified (ordinary) dividends are taxed as ordinary income instead.

Tax basis is what determines gain or loss when an asset is sold — sale price minus basis. A marginal tax bracket is the rate applied only to the last dollar earned, not the taxpayer's entire income. The Alternative Minimum Tax (AMT) is a parallel tax calculation that adds back certain preference items (like the bargain element on an incentive stock option at exercise, from Unit 1) that regular tax rules would otherwise exclude.

RMDs (required minimum distributions) force withdrawals from most tax-deferred retirement accounts starting at a specific age. IRMAA (income-related monthly adjustment amount) raises Medicare premiums for higher-income retirees.

Lesson 15.2: Business & Trust Taxation

Recall from Unit 16: a C-corporation faces double taxation — the company pays tax on its profits, then shareholders pay tax again on dividends received. Pass-through entities — partnerships, LLCs, S-corporations, and structures like REITs and MLPs (master limited partnerships) — avoid that entity-level tax entirely, passing income straight through to be taxed once, on the owners' personal returns.

Lesson 15.3: Wealth Transfer — Estate & Gift Tax

Each year, an individual can give up to the annual gift tax exclusion amount to as many recipients as they like, completely tax-free and without even needing to file a gift tax return. Gifts beyond that annual amount reduce the giver's lifetime unified credit/exemption — a single combined exemption that applies across both lifetime gifts and the taxable estate at death. Portability allows a surviving spouse to add any unused portion of their deceased spouse's exemption to their own.

Recall the basis rules that connect directly to this topic: gifted assets carry over the giver's original cost basis, while inherited assets step up to the date-of-death value (with the narrow exception that inherited annuities do not get that step-up).

Lesson 16.1: Individual & Entity Clients

The simplest client is an individual (natural person) or a sole proprietorship — one person, unlimited personal liability for any business debts. Beyond that, business entities differ sharply in liability and taxation:

• General partnership — unlimited liability for all partners; pass-through taxation.
• Limited partnership — the general partner(s) have unlimited liability, limited partners' liability is capped at their investment; pass-through taxation.
• LLC (Limited Liability Company) — limited liability for all members, combined with pass-through taxation — the best of both worlds structurally.
• C-corporation — limited liability, but double taxation (the corporation pays tax on profits, then shareholders pay tax again on dividends).
• S-corporation — limited liability with pass-through taxation, but capped at 100 U.S. shareholders.

Trusts, estates, foundations, and charities are also common advisory clients, each with their own governing documents dictating how the account must be managed.

Lesson 16.2: Account Ownership Types

• Individual — one owner, one tax ID.
• JTWROS (Joint Tenants with Rights of Survivorship) — two or more owners; when one dies, their share automatically passes to the surviving owner(s), avoiding probate.
• Tenants in Common (TIC) — fractional ownership; when one dies, their share goes to their own estate, not automatically to the other owner(s) — this does not avoid probate.
• Tenancy by the Entirety — available only to married couples, similar survivorship effect to JTWROS.
• Community property — property acquired during the marriage is jointly owned regardless of whose name appears on the title.
• TOD/POD (Transfer/Payable on Death) — names a beneficiary who has no control over the account until the owner's death, and avoids probate.

A beneficiary designation always overrides a will for that specific asset (retirement accounts, life insurance, TOD/POD accounts). A valid will, by itself, does not avoid probate — only trusts, JTWROS, TOD/POD, and beneficiary designations accomplish that.

Lesson 16.3: Special Accounts & Estate Planning

A UGMA/UTMA custodial account holds an irrevocable gift to a minor — even the donor, if also acting as custodian, can never reclaim the assets. Rules: one custodian, one minor, per account; no margin trading; and the custodian must manage the account exclusively for the minor's benefit.

A trust only accomplishes its purpose for assets that are actually funded into it — signing the trust document alone does nothing. An unfunded trust leaves those un-transferred assets to pass through probate (or intestacy) exactly as if the trust never existed.

Lesson 17.1: Financial Goals, Situation & Risk Tolerance

Every recommendation starts with understanding a client's financial goals (retirement, education funding, wealth preservation, etc.) and their current and future financial situation: cash flow (income vs. expenses), a personal balance sheet (assets, liabilities, net worth), existing investments, tax situation, and any Social Security or pension income already expected.

Risk tolerance (the client's psychological willingness to accept volatility) and risk capacity (their financial ability to withstand a loss without jeopardizing their goals) are two genuinely different things — a client might feel comfortable with aggressive investments (high tolerance) while having very little actual room to absorb a loss (low capacity), or vice versa.

Lesson 17.2: Time Horizon & Nonfinancial Considerations

Time horizon — how long until the funds are actually needed — directly shapes what level of risk and liquidity is appropriate; a goal 25 years away tolerates more volatility than one needing funding next year.

Beyond the numbers, nonfinancial considerations genuinely matter to suitability: values-based investing (ESG or religious criteria), the client's own investment experience, and life stage/life events (a young family building wealth vs. someone already in retirement drawing it down). Behavioral finance concepts — loss aversion, overconfidence, anchoring — describe predictable ways clients' emotions can distort their own decision-making, which an adviser should recognize and account for.

Lesson 17.3: Client Data Gathering

Advisers gather the information above through client identification procedures, structured questionnaires, and direct interviews. This isn't paperwork for its own sake — the entire suitability obligation depends on it. An adviser simply cannot make a suitable recommendation without first gathering enough information to know what "suitable" even means for that specific client.

Lesson 18.1: IRAs & Qualified Retirement Plans

A traditional IRA is generally funded with pre-tax (deductible) contributions, grows tax-deferred, and is taxed as ordinary income on withdrawal. A Roth IRA flips that: contributions are after-tax (no upfront deduction), but qualified withdrawals in retirement are completely tax-free.

Employer-sponsored qualified plans split into two structures: a defined benefit plan promises a specific payout formula at retirement (the employer bears the investment risk), while a defined contribution plan (401(k), 403(b), 457) only defines what goes in each period — the eventual payout depends entirely on how those contributions perform. SIMPLE IRAs and SEPs are simplified plans aimed at small businesses, and a Solo 401(k) serves a self-employed individual with no other employees.

Lesson 18.2: ERISA & Fiduciary Obligations

ERISA (the Employee Retirement Income Security Act) governs employer-sponsored retirement plans and holds plan fiduciaries to a strict duty to act solely in participants' interest. A QDIA (Qualified Default Investment Alternative) is the default investment a participant's contributions go into if they never make an active investment choice of their own. Plans operate under a written investment policy statement governing how assets are managed, and ERISA specifically bars certain prohibited transactions — such as self-dealing with plan assets or other conflicts of interest involving the people who control the plan.

Lesson 18.3: Education Funding & Nonqualified Plans

A 529 plan offers tax-free growth and tax-free withdrawals for qualified education expenses, generally with high contribution limits and the flexibility to change the named beneficiary. A Coverdell ESA offers similar tax-free treatment for education expenses (K-12 and college) but comes with much lower contribution limits and income-based eligibility phase-outs.

Nonqualified deferred compensation plans let select employees (typically executives) defer income to a future date without the contribution caps that apply to qualified plans — but in exchange, these plans lack the same creditor protections, and the employer generally can't take a tax deduction until the compensation is actually paid out.

Lesson 19.1: Systematic vs. Unsystematic Risk

Systematic (market) risk affects virtually every investment to some degree — interest rate risk, broad sector risk, geopolitical risk — and cannot be diversified away, since it's baked into the market as a whole. Unsystematic (specific) risk — credit risk, legal/regulatory risk, financial risk, issuer-specific risk — is tied to one particular company or issuer, and can be reduced through diversification across many holdings (Unit 21).

Lesson 19.2: Opportunity Cost & Capital Structure Risk

Opportunity cost is the return given up by choosing one investment over the next-best available alternative — it's a real cost even though no cash actually leaves anyone's pocket.

A company's capital structure determines risk hierarchy in the event of trouble: secured debt → unsecured debt → preferred stock → common stock, from most senior (paid first, lowest risk) to most junior (paid last, highest risk). This is the same liquidation order established in Unit 2.

Lesson 19.3: Naming the Specific Risk Types

Several named risks recur throughout the course, and exam questions often expect you to match a scenario to the correct name:

• Interest rate risk — bond prices move opposite interest rates (the seesaw, Unit 2).
• Credit/default risk — the issuer fails to make interest or principal payments.
• Reinvestment risk — having to reinvest proceeds (like a called bond, Unit 2) at a lower prevailing rate.
• Inflation/purchasing power risk — fixed-income investments are especially vulnerable, since a fixed payment buys less over time.
• Liquidity risk — the inability to sell an investment quickly without accepting an unfavorable price.

Lesson 20.1: Time Value of Money

Future Value (FV) answers "what will a sum grow to?" — the logic behind the Rule of 72 shortcut (72 ÷ rate ≈ years to double). Net Present Value (NPV) works in reverse: it discounts a stream of expected future cash flows back to today's dollars using a required rate of return, then subtracts the initial cost. A positive NPV means the investment is expected to earn more than the required rate — generally a "go" signal; a negative NPV suggests passing on it.

Internal Rate of Return (IRR) is the specific discount rate that makes an investment's NPV exactly zero — in effect, the investment's own break-even rate of return. Comparing an investment's IRR to a required rate of return is another way of asking the same NPV question.

Lesson 20.2: Descriptive Statistics & Risk-Adjusted Returns

Standard deviation measures how much an investment's returns bounce around its own average — the higher the standard deviation, the more volatile (risky) the investment. Correlation (ranging from −1 to +1) measures how two investments move relative to each other; the closer to −1, the more they move in opposite directions, and pairing negatively- or low-correlated assets is exactly what makes diversification reduce risk.

Beta measures an investment's systematic (market) risk — a beta of 1.0 moves in line with the market, not "no risk." Alpha measures performance relative to what the Capital Asset Pricing Model (CAPM) predicted for that level of risk — a portfolio can gain 12% and still show negative alpha if the model predicted 15% given its beta.

Both the Sharpe ratio and Treynor ratio divide a portfolio's excess return over the risk-free rate by a measure of risk — Sharpe uses standard deviation (total risk), appropriate for evaluating a standalone portfolio; Treynor uses beta (systematic risk only), appropriate for evaluating one holding being added to an already-diversified portfolio, since unsystematic risk gets diversified away at that point.

Lesson 20.3: Financial Ratios & Valuation

Two liquidity ratios test a company's ability to cover short-term obligations: the current ratio (current assets ÷ current liabilities) and the stricter quick ratio ("acid test"), which excludes inventory — the least liquid current asset — from the numerator. The debt-to-equity ratio measures leverage: how much of the company is financed by debt versus shareholder equity.

Two valuation ratios compare a stock's price to its fundamentals: P/E (price-to-earnings) shows how much investors are paying per dollar of current earnings — a higher P/E often signals higher growth expectations. P/B (price-to-book) compares price to the company's net asset value per share.

Lesson 21.1: Capital Market Theories

The Capital Asset Pricing Model (CAPM) relates an investment's expected return to its systematic risk (beta): expected return = risk-free rate + beta × (market return − risk-free rate). It's the model used to derive the "expected" return that alpha (Unit 20) measures performance against.

Modern Portfolio Theory (MPT) holds that combining assets with low or negative correlation can reduce a portfolio's overall risk without necessarily sacrificing expected return — the "efficient frontier" is the set of portfolios offering the highest expected return for each level of risk.

The Efficient Market Hypothesis (EMH) comes in three forms, each claiming prices already reflect a different scope of information:

• Weak form — prices reflect all past price and volume data, so technical analysis can't provide an edge (fundamental analysis still might).
• Semi-strong form — prices reflect all publicly available information, so neither technical nor fundamental analysis of public information can provide an edge.
• Strong form — prices reflect literally all information, public or private, meaning not even insider information could produce a consistent edge.

Lesson 21.2: Asset Allocation & Investment Styles

Strategic asset allocation sets a long-term target mix (e.g., 60% stocks/40% bonds) and periodically rebalances back to it. Tactical asset allocation deliberately deviates from that long-term target for shorter stretches to try to exploit a perceived short-term market opportunity.

Investment styles come in contrasting pairs: active management tries to beat a benchmark through manager skill (higher fees); passive management simply tracks an index (lower fees). Growth investing targets companies with above-average expected earnings growth (often at a higher P/E); value investing targets companies that appear underpriced relative to their fundamentals (often a lower P/E). Income style emphasizes dividends/interest; capital appreciation style emphasizes price growth instead.

Lesson 21.3: Portfolio Techniques

Diversification — spreading investments across assets that don't move in lockstep — reduces unsystematic (company/sector-specific) risk. It cannot eliminate systematic (market-wide) risk, which affects virtually everything to some degree. Sector rotation shifts allocations among sectors based on where the economy sits in the business cycle (Unit 6).

Dollar-cost averaging — investing a fixed dollar amount at regular intervals — automatically buys more shares when the price is low and fewer when it's high, lowering the average cost per share over time. It does not guarantee a profit or protect against loss in a continuously declining market.

Leveraging (using borrowed money) amplifies both gains and losses. Leveraged and inverse funds are designed to move at a multiple of, or opposite to, an index — but due to daily rebalancing and compounding effects, they're built for short-term/day-trading use, not long-term buy-and-hold.

Lesson 22.1: Time-Weighted vs. Dollar-Weighted Return

Time-weighted return measures a manager's stock-picking skill in isolation — it assumes a single lump sum invested at the start of the period, held with no additions or withdrawals, so investor behavior can't distort the number. This is the figure reported in fund fact sheets and financial media. Dollar-weighted return (an internal-rate-of-return calculation) instead reflects what a specific investor actually experienced, factoring in the exact size and timing of their own deposits and withdrawals — a fund can post a strong time-weighted return for the year while an investor who bought near a peak and sold near a trough sees a far worse, even negative, personal return.

Lesson 22.2: Other Return Measures

Total return = (dividends + interest + capital gains − capital losses) ÷ original cost — capturing both of the only two ways an investment makes money: income and price appreciation. Holding period return is simply the return earned over the specific length of time an investment was actually held, without annualizing it. To compare returns from different time periods on equal footing, you annualize a partial-period return by scaling it to a full year.

Inflation-adjusted (real) return = nominal return − inflation rate (CPI) — the number that reflects an actual gain in purchasing power. After-tax return further subtracts the investor's tax cost. Current yield = annual income ÷ current market price — notably different from a bond's fixed coupon rate, since current yield moves as the bond's price moves even though the coupon never changes.

Lesson 22.3: Risk-Adjusted Returns & Benchmarks

A risk-adjusted return measure — the Sharpe ratio and Treynor ratio from Unit 20 — answers "how much return did this investment earn per unit of risk taken," rather than just looking at raw return in isolation. Two portfolios with identical returns aren't necessarily equally good if one took on much more risk to get there.

Comparing a portfolio to a benchmark only means something if the benchmark actually matches the portfolio's asset class and style — a large-cap U.S. stock fund should be measured against a large-cap U.S. stock index, not against a bond index or a small-cap index. An irrelevant benchmark makes any performance comparison meaningless.

Lesson 23.1: Bids, Offers & Order Types

The bid is the highest price a buyer is currently willing to pay; the offer (ask) is the lowest price a seller is currently willing to accept. The gap between them is the spread.

Four order types, and what each one guarantees:

• Market order — no price specified. Guarantees execution, not price.
• Limit order — one price specified. Guarantees price (or better), not execution — it may never fill if the market doesn't reach that price.
• Stop order — one price specified (the "stop price"). Once the market reaches it, the order becomes a market order and executes at whatever the next available price is.
• Stop-limit order — two prices specified. Once triggered, it becomes a limit order instead of a market order — meaning it could still fail to execute even after triggering.

Order qualifiers add extra conditions: AON (All-or-None) can wait indefinitely but won't accept a partial fill; IOC (Immediate-or-Cancel) won't wait but accepts a partial fill; FOK (Fill-or-Kill) combines both restrictions — it must fill completely, immediately, or it's cancelled entirely.

Lesson 23.2: Account Types & Short Selling

A cash account requires full payment for securities purchased — no borrowing. A margin account lets an investor borrow part of the purchase price from the broker-dealer, using the securities themselves as collateral, subject to initial and maintenance margin requirements.

Short selling — borrowing shares to sell them now, hoping to buy them back later at a lower price — requires a margin account. It carries a unique risk profile: since a stock's price has no ceiling, a short seller's potential loss is theoretically unlimited, unlike a long position where the most you can lose is your original investment.

Full discretionary authority means the adviser decides all three of: what to buy/sell, whether to buy/sell, and how much. If the client has already specified what and how much, and only lets the rep pick the timing and price, that's merely time-and-price discretion — a meaningfully lower bar that does not require the same discretionary account paperwork.

Lesson 23.3: Trading Roles, Capacity & Costs

An introducing broker-dealer handles the client relationship (opening accounts, taking orders) but relies on a clearing broker-dealer/custodian to actually hold assets and settle trades. Market makers stand ready to buy and sell a security continuously, and exchanges provide the venue where trading actually happens.

Every trade is executed in one of two capacities: agent/broker capacity, where the firm simply finds a counterparty and charges a commission, or dealer/principal capacity, where the firm trades from its own inventory and charges a markup or markdown instead. A firm can never charge both on the same trade, and the confirmation must disclose which capacity applied.

Firms owe clients best execution — seeking the most favorable terms reasonably available under the circumstances, not necessarily the single lowest price in isolation. Payment for order flow (PFOF) — compensation a broker receives for routing orders to a particular market maker — is legal and must be disclosed, but never excuses a firm from still seeking best execution for the client.

Lesson 24.1: Annuities

An annuity is a contract with an insurance company: money goes in during an accumulation phase, then comes back out during a payout (annuitization) phase. Three types:

• Fixed annuity — the insurance company bears the investment risk and guarantees a minimum rate. Not a security.
• Variable annuity — the owner's money is invested in subaccounts (similar to mutual funds), so the owner bears the investment risk. This is a security requiring registration.
• Indexed (equity-indexed) annuity — returns are tied to an index, but bounded by a cap (maximum credited return) and a floor (usually 0% — protects against loss, but doesn't guarantee a gain every year). The insurer bears the risk, within those bounds. Not a security.

Lesson 24.2: Annuity Taxation & Contract Features

Annuity withdrawals follow LIFO ("last in, first out") — the growth (the most recently added value) comes out first and is taxed as ordinary income; only after all the growth is withdrawn does the owner start receiving their own already-taxed principal back, tax-free.

A free-look period is a short, one-time window right after purchase to cancel for a full refund. A surrender charge penalizes withdrawing too early, applying over a much longer stretch of years — and it declines over time, typically starting high and shrinking to zero.

A 1035 exchange moves money between insurance/annuity products tax-deferred (not tax-eliminated). Life insurance → annuity is allowed. Annuity → life insurance is generally NOT allowed — a real, testable one-way restriction.

Lesson 24.3: Life Insurance

Term life provides temporary coverage with no cash value. Whole life, universal life, and variable universal life are "permanent" policies that build cash value alongside a death benefit. Of these, only variable life and variable universal life are securities — term, whole, and non-variable universal life are not.

Life insurance cash-value withdrawals follow the opposite convention from annuities: FIFO ("first in, first out") — the owner's own premium comes out first, tax-free (since it was already taxed money), and only once withdrawals exceed total premiums paid does the taxable growth get touched.

Common riders: a waiver of premium rider is triggered by disability; an accelerated death benefit rider is triggered by terminal illness. Both can exist on the same policy simultaneously, since they respond to different triggers.